Britain's economic crisis deepens even as others recover

The news from the Organisation for Economic Cooperation and Development's latest economic assessment all looks pretty positive – positive that is until you get to the forecast dealing with Britain. Unlike the rest of the G7, where the projected size of the economic contraction for this year has either been revised down or left unchanged, the UK has been revised up from negative growth of 4.3 per cent to 4.7 per cent (see table below). I don't want to intrude on private grief, but the UK Treasury's own forecast still stands at a gloriously irrelevant 3.5 per cent.

OECD assessment of GDP growth in the G7 countries (click the table to enlarge it)

Yet we perhaps shouldn't read too much into the OECD's apparently damning projection, as much of the deterioration is accounted for by the fact that the UK's own Office for National Statistics has revised up estimates of the fall in economic activity for the first and second quarters. This has caused the OECD's forecast for the year as a whole to be cut even though it has improved its projections for the third and fourth quarter. In other words, the UK broadly conforms to the OECD's wider assessment of the outlook for the G7 of a rather earlier recovery than envisaged a few months back, abeit not as good as the one being projected for almost everywhere else.

In the City, the mood is one of growing optimism with a significant number of economists and pundits now predicting a sharp, V-shaped recovery in economic activity. Here's one reasonably representative example of the new consensus from Tim Bond, head of global asset allocation at Barclays Capital. "Recent data releases", he says, "continue to build a strong case in favour of the V-shaped recovery. Leading indicators are now strongly suggesting that a US labour market recovery is just around the corner, with commensurately bullish implications for spending. We note how employment growth is also good news for banks, serving to further curtail loan lossses on consumer debt, residential mortgages and commercial real estate loans".

Mr Bond is referring more to the global and US economies than Britain, but his remarks might equally well apply to the UK. Still, as the OECD observes, there are numerous headwinds, so the pace of recovery is likely to be modest for some time to come. Ahead of this weekend's G20 meeting of finance ministers in London, the OECD warns strongly against any premature tightening of fiscal or monetary policy. Interest rates are going to have to remain at their current low levels well into 2010 and in some cases even beyond. By some cases, does the OECD mean Britain?

The UK economy's high exposure to the financial services industry, its extreme levels of personal indebtedness and its heavy reliance on a once booming housing market initially made it seem much more vulnerable than others to the banking implosion and accompanying economic slowdown. But as export markets dried up, others found themselves equally affected, and it seems likely that when all this is over, most of the major developed economies will have suffered a contraction of roughly equal magnitude, give or take a point or two. Germany and Japan seem to be coming out of recession earlier than the UK, but the scale of the earlier, inventory led contraction was much deeper. Ironically, the US, whose housing meltdown was the initial cause of the crisis, is now looking as if it will come through less damaged than most.

As for Britain, the much maligned financial services industry is now rebounding so strongly that some banks are telling their traders to "cool it", so embarrassingly large are the profits they are generating. Lord Turner, chairman of the Financial Services Authority, wants to shrink the City to a more "socially responsible" size, but perhaps he ought to take lessons from St Augustine – please make us chaste, but not yet. The recovery in banking ought eventually to instruct a wider economic rebound.

So no repeat of the Great Depression then? It seems not, but the damage inflicted by the worst banking crisis in history is none the less quite bad enough. The banking sector, with quite a bit of help from the US and UK governments, has wrecked the economy and wrecked the public finances. The coming fiscal consolidation will crimp growth for years to come.